To Chanika Takar and Rekit Pachanekar

If you think that investing in options is just another way to make money and was created by smart people in suits who work on Wall Street, you are wrong. The world of options is far ahead of modern stock exchanges.

Some credit the Samurai for giving us the foundation upon which our options contracts were based. Some others admit that the Greeks provided us with ideas of how to deduce commodities. In this case, the harvest of olives.

In both cases, humans were trying to guess the price of groceries and trade accordingly (rice for samurai). Long before the modern world laid down rules and set up exchanges.

## What is options trading?

Before we delve into the basics of options trading, let’s take a moment to understand what options trading is and why we need options.

Let’s take a very simple example to understand options trading.

Consider that you are buying a stock with Rs. 3000. But the broker tells me about an exciting offer that you can buy now for Rs. You can give token amount of 3000 or Rs. We reserve the right to purchase for 30 rupees. 3000 a month later, even if the stock went up in value at that point. But that token amount is non-refundable!

I noticed that the stock price is likely to exceed the rupee. 3030, so you can at least breakeven. As you have to pay only Rs. The remaining amount can be used elsewhere for a month. Wait a month, then check the stock price.

Now, depending on the stock price, you can choose whether to buy the stock from your broker or not. Of course, this is an oversimplification, but this is the gist of options trading.

In the trading world, options are products that belong to the derivative family. That is, its price comes from something else (mostly stocks). An option’s price is inherently linked to the price of the underlying asset.

## Common terms used in options trading:

For options trading, we use certain terms to create a successful strategy. Learn about these common terms when trading options. These terms are:

- phone
- put
- strike price
- premium
- underlying asset
- expiry date
- option style
- money

### phone

Ah call options am option A contract that gives the purchaser of the contract the right, but not the obligation, to purchase the underlying asset. safety At a strike price on or before the expiration date (depending on the option type). The seller or writer of a call option is obliged to sell the underlying asset if the buyer of the contract chooses to exercise its right to purchase the underlying asset.

### put

put option Gives the option buyer (holder) the right to sell the underlying asset at a fixed price (strike price or strike price) after a specified time period (in Europe, at expiration, any time before expiration) It is a derivative product. for American options).

The put option seller (put writer) has a contingent obligation to purchase the underlying asset if the put holder wishes to exercise the option. Because options give the buyer a choice as to whether or not to exercise the option, the seller charges the buyer a fixed upfront fee (called a premium).

### strike price

of strike price The price at which the underlying stock can be bought or sold according to the contract. In options trading, the strike price of a call option is the price at which the stock can be purchased on or before the expiration date. For put option trading, the share price is the price at which the seller of the underlying asset can exercise its right to sell the underlying asset (at or before expiration).

### premium

The option premium is the price you have to pay to buy the option, as the option itself has no underlying value. The premium is determined by multiple factors including the underlying stock price, market volatility and the number of days to maturity of the option. In options trading, premium selection is one of the most important factors.

### underlying asset

In options trading, the underlying asset can be stocks, futures, indices, commodities, or currencies. An option’s price is derived from its underlying asset. For the purposes of this article, we will consider the underlying asset to be a stock. An option on a stock gives the holder the right to buy or sell the stock at a specified price and date.

### expiry date

In options trading, all stock options have an expiration date. The expiry date is also the last date an option holder can exercise the right to buy or sell an option held. In options trading, option expiry dates vary from weeks to months to years, depending on the market and regulations.

### option style

There are two main types of options practiced in most options trading markets.

- American options that can be exercised at any time before the expiration date
- European options that can only be exercised on the expiry date

### Moneyness (ITM, OTM, ATM)

Before you start trading stock options, it is very important to understand the option amount. Many options trading strategies revolve around the monetary value of options.

It basically defines the relationship between the strike price of the option and the current price of the underlying asset. Below is a brief description of each term.

### When are options in the money?

- Call option – if the underlying stock price is higher than the strike price
- Put option – if the underlying stock price is lower than the strike price

### When are options out of the money?

- Call option – if the underlying stock price is lower than the strike price
- Put option – if the underlying stock price is higher than the strike price

### When is Option at the Money?

- If the underlying stock price equals the exercise price.

Take a short break here and reflect on the various terms. You will find it very useful later on when considering option types and some options trading strategies.

## example

To better understand call and put options and strategies built on both, let’s look at two examples.

For simplicity, let’s assume:

- Stock price when option was written: $100
- Premium: $5
- Expiration date: 1 month after option purchase

### case 1:

Current stock price: $110. Strike price: $120

### Case 2:

Current stock price: $120. Strike price: $110

## Option type

There are really only two types of options: calls and puts. To learn more about options trading, understand them in more detail.learning Machine learning for options trading See the Quantra course for more information.

### A put-call option from the buyer’s perspective

In order to make a profit, the price of the stock must fall from the strike price plus the premium of the put option purchased before or at maturity. Similarly, to profit from a call option, the price of the underlying asset must be higher than the strike price plus the premium for the call option purchased before or at expiration.

In this way, the loss of the buyer of both put and call options is limited to the premium paid, but the profit is unlimited. The above description is from the buyer’s point of view.

### A put-call option from the seller’s perspective

Now, understand the put call option from the perspective of the seller, the option writer. The put option seller is obligated to purchase the underlying asset at the strike price in exchange for the premium charged.

Similarly, in exchange for the premium charged, the call option seller is obligated to sell the underlying asset at the strike price.

## Visualize options profit and loss

So is there a way to visualize the potential profit/loss for option buyers or sellers?

An option payoff diagram is a graphical representation of net profit/loss by option buyers and sellers.

Before proceeding to their respective representations in the diagram, let’s understand what the four terms mean. We know that short means selling an asset and long means buying an asset, so the same principle applies to options.

With this in mind, let’s look at four terms:

- Short Call – Here we are betting that the price will fall, so a short call means we are selling a call.
- Short Put – A short put here means that you are selling a put option.
- Long Call – means you are buying a call option because you are optimistic about the underlying stock price.
- Long Put – Here you are buying a put option.

## Option Payoff Diagram

Going forward, we will discuss payoff diagrams for the following options:

Where,

S = original price

X = strike price

The break-even point is the point at which there is neither profit nor loss.

Long call holders make a profit equal to the share price at expiration minus the strike price minus the premium if the option is in the money. The holder of a call option suffers a loss equal to the premium if the option runs out of money at the expiration of the option and the option writer makes a constant profit equal to the option her premium.

Similarly, if the option is in-the-money and is equal to the strike price minus the stock price at expiration minus the premium, the put option buyer benefits. And the put writer makes a profit equal to the premium of the option.

## Option Trading vs Stock Trading

There must be a question in your mind as to why there is option trading when it is just another way of trading. Now, here are some points that differ from stock trading:

- Option contracts, unlike stocks, have expiration dates. Expiration dates can vary from weeks to months to years, depending on regulations and the type of options you have in practice. Stocks, on the other hand, do not expire.
- Unlike stocks, options derive value from other things and therefore fall into the derivative category.
- Options are not numerical like stocks
- Option holders have no rights (voting rights or dividends) in the company, unlike stock holders.

Many people find it difficult to understand the concept of options, even though other transactions, such as auto insurance and mortgages, already follow the concept of options.This part of the article describes some of the most important Advanced options trading Before we get into the world of options trading, let me explain some aspects.

Last but not least, via a curated list of some of the most demanding blogs on options trading written by experts! You can navigate through the topics to get the knowledge you need for options trading starting with the basics.

### Conclusion

We have covered all the basics of options trading, including the terms and types of different options. We have also provided examples for newbies to options trading and for Option Greeks. Before opening an options trading account, you have understood various options trading strategies and considerations.

If you are interested in the basics of options trading, this blog is a great place to start. However, if you want to continue learning on your own, you need a free options trading course. We’ll start with the basic terms and concepts you need to know to be able to trade options.

The world of options trading is not limited to this. To move forward, we need to start using options and quantitative methods. futures trading Learn how to create options pricing models, options greek, and different strategies.Our learning track allows you to Developing quantitative approaches in futures and options trading.

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